SEBI’s push for retail algo trading raises questions that cannot be ignored

Algo Trading – It is fast, and able to execute multiple trades in just milliseconds, which humans cannot achieve. It also removes the emotional element from trading, a constant battle that investors have to fight. Sounds good right? Well, not so straight forward.

India’s markets regulator Sebi’s renewed push to encourage retail investors to adopt algorithmic trading — where pre-determined computer programs execute trades — has sparked an interesting debate. While the proposed measure holds promise, there are questions about its complexity and practicality in a market where such tools are largely limited to institutional investors.

Algo trading first reached Indian markets when SEBI introduced Direct Market Access (DMA), where institutional investors were allowed to execute trades using algorithms without the intervention of a broker.

Retail algo trading in India has been gaining traction in the recent past with free access to APIs. However, adoption rates remain low due to a combination of factors including lack of awareness and education about algo systems as many retail investors consider them too complex or believe they are reserved for institutions.

Moreover, technical requirements and perceived costs discourage widespread participation.

Currently, algo trading accounts for about 70% of the total market volume on exchanges, but is still largely limited to large investors. A recent Sebi study found that during FY2024, algorithmic trading accounted for 97% of foreign investors’ and 96% of proprietary traders’ futures and options.

Considering these figures, it is no wonder that SEBI is making efforts to make it more accessible to investors. However, the proposals received a mixed response.

Also Read: What Zerodha’s Nitin Kamath has to say about SEBI’s push for retail algo trading

The regulator said algos need to be registered by brokers on the exchange, ensuring that all trading strategies are properly vetted and consistent.

A major point of contention for traders is that a carefully crafted strategy, which may require multiple changes if needed, can make the entire process cumbersome, where time is an important factor in investing.

Shruti Jain, Chief Strategy Officer, Arihant Capital Markets said, “Stock markets are dynamic, and time is of the essence for traders. If a strategy takes a long time to execute due to lengthy approval process, it can lose its effectiveness.”

SEBI has started an expedited registration process for the algorithm for faster approvals. However, the actual turnaround time still depends on the exchanges, so its effectiveness, in reality, remains to be seen.

Also Read: SEBI Proposes To Allow Retail Investors To Participate In Algo Trading

“While SEBI has mandated that exchanges should provide TAT for approvals, the sheer volume of iterations can create a never-ending queue and thus stifle innovation and growth of this segment. We need more clarity on this,” Tejas said. Khode said. Co-founder and CEO of FYERS, one of the few brokers in India that facilitates algo trading via API.

One possible solution could allow pre-approved frameworks or categories of strategies, giving traders the flexibility to make minor adjustments without requiring new approval each time. The provision of white box algos, which the regulator proposed, could provide flexibility with tweaking strategies without requiring approval for every small change.

Kunal Nandwani, co-founder of UTrade Solutions, a fintech company that provides software for trading, argues that SEBI’s proposals formalize retail investors’ access to algo trading with proper infrastructure and safeguards.

“Over time the algo approval process can be simplified and expedited as needed. It is certainly better than misleading retail investors in an unregulated market,” Nandwani said.

SEBI has also proposed that the API (Application Program Interface), through which investors can create their own strategies and execute trades, will require two-factor authentication and whitelisting to ensure traceability and prevent misuse. Exchanges will also need to monitor compliance, provide unique identifiers for algorithms and ensure audit trails.

Khode says that while the proposed rules may initially cause some friction, they will ultimately build trust and credibility, making algo trading more attractive to a wider audience.

(disclaimer: Recommendations, suggestions, opinions and views given by experts are their own. (These do not represent the views of The Economic Times)